A Crowded Currency Hedged ETF Trend

March 12, 2015

An astonishing $12 billion has flowed into the WisdomTree Europe Hedged Equity Fund (HEDJ | B-51) in the past year, and truth be told, it’s been money well invested.

But the increasingly powerful flows into HEDJ make me wonder if investors aren’t starting to chase returns. Consider this: More than $7 billion has flowed into the ETF market’s most popular fund so far this year, and more than $2 billion of that has come this month alone.

Yes, the eurozone is poised for a rebound—in terms of a near-term reversion to the mean and, in the longer term, perhaps a more lasting bull run based on the European Central Bank’s commitment to fight deflation through quantitative easing.

Hedging Has Fueled Returns

Consider that the currency hedge on HEDJ, for U.S. investors, has made a winner of a neutral investment in the past 12 months. The blue line in the chart below is the CurrencyShares Euro ETF (FXE | B-98), the euro-dollar cross in an exchange-traded wrapper.

There’s an elegant mirror-like quality to the chart that isolates the currency factor rather cleanly. Were it not for the currency hedge, HEDJ would be about flat.

Parity In Sight

Growing consensus is that the euro will reach parity with the dollar before long.

It now takes about $1.06 to buy one euro. That’s down from about $1.38 a year ago and nearly $1.48 back in the spring of 2011, just before the eurozone's debt crisis began to deepen. Much of this move, recently in particular, is based on the ECB’s being committed to carry out an aggressive QE program, so more euro weakness against the dollar seems in the cards.

That said, markets are imperfect and are notorious for overshooting underlying fundamentals.

So, it stands to reason that these powerful inflows into HEDJ and other currency-hedged strategies such as the Japan-focused WisdomTree Japan Hedged Equity Fund (DXJ | B-57) and the MSCI EAFE Index-focused Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF | B-71) might be a bit much.

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